niveshak december 2012 issue

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THE INVESTOR VOLUME 5 ISSUE 12 December 2012

economic Impact of Mega

Events in Brazil, pG. 08

New Private Sector Banks in

India, PG. 21


2/28Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bearsno responsibility whatsoever.

F R O M E D I T O R S D E S K

NiveshakVolume V

ISSUE XII

December 2012

Faculty Mentor

Prof. P. Saravanan

Editorial Team

Akanksha Behl

Akhil Tandon

Chandan Gupta

Harshali Damle

Kailash V. Madan

Nilkesh Patra

Rakesh Agarwal

New TeamAnchal Khaneja

Anushri Bansal

Gourav Sachdeva

Himanshu Arora

Ishaan Mohan

Kaushal Kumar Ghai

Nirmit Mohan

Creative Team

Anuroop Bhanu

Kritika NemaNeha Misra

Venkata Abhiram M.

All images, design and artwork

are copyright of

IIM Shillong Finance Club

Finance Club

Indian Institute of ManagementShillong

www.iims-niveshak.com

THE TEAM

Dear Niveshasks,

The latest fad to make inroads in the Indian economy om the global

arena is FDI in multi brand retail. It was passed by both houses in the

just concluded winter session of the parliament. But come Januar

1st and we witess the rollout of undoubtedly the biggest scheme in

the histor of independent India.

Our cover stor focuses on the same and we evaluate the suitabilit

of cash tansfer schemes for India of today. We also poray the India

where cash tansfers can be exemely successfl. Is India ready to

embrace this latest oering om the West? Tur on the pages to ndout.

The success (failure?) of the cash tansfers will be something to watch

out for and we sure will keep a tab on that; but are the 2014 FIFA

World Cup and the 2016 Olypics not something to watch out for

as well? Ageed that its a lile too early to foresee these events but

isnt Niveshak all about keeping you ahead of the times! This issues

Aricle of the Month analyses the eects of these events on the Brazil-

ian economy. While this aricle takes you years ahead, our Finistor

aricle takes you about a centr back to the era of World War I and

analyzes the tansforation of the US economy in that period.

This month, our Finance Minister, Mr. P. Chidambaram, advised RBI

to proceed ahead with issuing of new banking licenses without wait-

ing for amendment of the Banking Reglation Act of 1949. Is this the

beginning of a new chapter in the ever-dyamic relationship of the

Goverment of India with its cental bank? Exlore the same in the

FinGyaan section of this issue.

We continue to receive your suppor in the for of aricles and FinQenties and our sincere thanks goes out to all our esteemed readers

for the same. We would also like to thank all the paricipants for

an overhelming response to our intercollege rst-of-its-kind event

FinDrishti. Please continue to motivate us so that we can come out

with more insightfl reads in the issues to come. And as always,

Stay Invested!

Team Niveshak


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C O N T E N T S

Niveshak Times

04The Month That Was

Article of the month

08 Economic Impact of theMega Events in Brazil

Cover Story

11All that Glitters is not Cash

FinGyaan14 Government of India and

RBI: An Evolving Relationship

Finistory17 Transformation of USEconomy during World War I

Finsight

21 New Private Sector Banksin India: An Industry Analysis

CLASSROOM

25 Bond Laddering


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Gujarat votes for Modi

Narendra Modi has once again been chosen as

the leader of the state on December 20, when

BJP recorded a staggering victory over the

arch rival Congress. BJP captured 115 seats in

the state assembly

where Congress

could only secure

61 out of 182 seats.

With this, Narendra

Modi completed

a hat-trick in the

state elections. This

victory has assured the Bhartiya Janata Party

of the popularity this assertive man enjoys in

the state. It also raises the prospects of him

becoming the BJPs prime ministerial candidatein the upcoming general elections. Meanwhile, it

was not a great show by the BJP in the northern

hill state of Himachal Pradesh, where the saffron

party was ousted from power by the Congress

which secured 36 out of 68 seats in the state

assembly.

Obama proposes to cut Social Security

As an attempt to avoid the possibility of

fiscal cliff, the White House has indicated that

significant cuts will be made to the socialsecurity and health programs for the poor and

the elderly of the nation. The Bush tax cuts

that benefit some of the wealthiest of the

country are on the way to become permanent,

whereas the payroll tax cuts that were hailed

by many economists might be allowed to

lapse. The White House calls this cut in social

securities and other programs as adjustments

and calculates it by changing the way in which

cost of living adjustments are calculated. The

proposed change in the policy would be known

as Chained CPI. These indications have invited

wrath of the public which is outraged by such a

move. It remains to be seen whether the Senateapproves of these changes.

FDI in Multi-Brand Retail becomes a

reality

The Upper House of the Indian Parliament onDecember 6 put its stamp of approval on thegovernments decision to allow Foreign Direct

Investment in multi-brand retail. This bringsto an end the protests, the debates and theopposition that the country had now witnessedfor months. The votes in Rajya Sabha pavedway for the International chains in Multi-brandretail to enter the lucrative Indian market. Now,retailers like Wal-Mart, Tesco and Carrefour arefree to deal directly with the state governments.

It would take another 18-24 months before anyof these chains can possibly set up their storesin India. The problem now is that many of thesestates will see transition in their governmentsin this period. It remains to be seen whetherthis transition will bring additional problems forthese eager to enter Indian markets firms.

The legacy of Ratan Tata

The TATA group is set to witness transition at thetop with the legendary Mr. Ratan Tata steppingdown as the Chairman of the largest Indianconglomerate with annual revenues of overUSD 100 billion. Mr. Cyrus Pallonji Mistry (44)takes over from Mr. Tata, who has served at thehelm of the affairs for 21 years, on December28, 2012. The nomination of young Mr. Mistryis in line with the groups objective of infusingyoung blood in the groups leadership. Mr. Tata

leaves behind him a strong legacy of aggressivebut ethical leadership. He is the name behindthe conceptualization of Nano, the car of thecentury according to many. Other feathers inhis cap include Corus, Jaguar Land Rover and

The Niveshak Times


IIM Shillong

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Starbucks etc. A lot is now expected from theyoung enthusiast who will move in to leadan organization that in the last few years hasrepresented India on the world stage. Thecountry wishes him luck and hopes that hecontinues the good work the Group is knownfor.

Japanese Firms Look towards India

Japans two biggest corporations, Hitachi andPanasonic, have identified India as one of the

growth centers and a base to expand in Africaand Middle East Markets. Hitachi, Japans largestindustrial power and electronics conglomeratehas formulated a India business strategy2015 plan to make the country one of its topmarkets and targets a three-fold jump in itsIndia revenues to Rs. 20,000 crore by 2015-16with an investment of Rs. 4700 crores in form of5 manufacturing plants across India. Similarly,Panasonic has lined up more than Rs. 1,000crore investments in a new plant at Haryana

and targets Rs 20,000-crore revenues by 2014-15,a year earlier than Hitachi. Yorihisa Shiokawa,Panasonics managing executive officer andchief of the APMEA operations, said the firmwants to set up more such plants and becomethe countrys largest appliances maker by 2018.

RBI keeps policy rates unchanged

The Reserve Bank of India (RBI), during itsmonthly monetary policy review preferred tokeep the key policy rates including the cash

reserve ratio (CRR) unchanged. While the reporate was maintained at 8%, CRR was alsomaintained at status quo of 4.25%. Describing itas a strategic move to control inflation, RBI hintedat easing rates in January (scheduled on 29th

January, 2013) inorder to shift focustowards growthfrom inflation.

The central bank

has been underenormous pressureto cut rates fromindustry and theFinance Ministry,

both of which believe a monetary easing at thisstage will lift spirits and ultimately aid in growthreviving.

NIB shapes up as Cabinet Committee of

Investment

National Investment Board (NIB), one of therecommendations from the CAG report whichwas released in May this year on allocation ofcoal blocks, ultimately has been shaped up asa Cabinet Committee on Investment (CCI). This

committee will reside in the cabinet secretariat,will be chaired by prime minister and comprisemembers from various ministries. In line withthe operations of Foreign Invest PromotionBoard (FIPB), this committee will acts as asingle window clearance for large infrastructureprojects worth Rs. 1,000 crores or above. It willalso monitor the progress of decision making andimplementation of projects of such magnitude.In India, there are as many as 90 such projectsover Rs. 1,000 crore pending clearances in

various ministries.ETF for CPSE to formalize soon

After the success of Rs.15,000 croresdisinvestment programs approved in September,Government is likely to soon set up an ExchangeTraded Fund (ETF) comprising stocks of listedCentral Public Sector Enterprises (CPSEs). It isbeing treated as a move to create an additionalmechanism to meet the disinvestment target ofRs. 30,000 crore for this fiscal.

ETFs were introduced in India in 2001. Currently,there are 33 ETFs having AUM (Assets underManagement) of close to Rs. 11,500 crore andheld by 6.2 lakh investors. Owing to the weakcorrelation between Gold and Share Markets,Gold ETFs dominate the ETF market in the country.Globally, ETFs have been growing at a rapid pacewith an annual growth rate of over 34% in thelast decade, with Assets under Management of$1.5 trillion at present.

The Niveshak Times

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MARKET CAP (IN RS. CR)BSE Mkt. Cap 6,864,893

Index Full Mkt. Cap 3,166,830

Index Free Float Mkt. Cap 1,652,684

CURRENCY RATESINR / 1 USD 54.84

INR / 1 Euro 72.47

INR / 100 Jap. YEN 65.31

INR / 1 Pound Sterling 89.11

POLICY RATESBank Rate 9.00%

Repo rate 8.00%

Reverse Repo rate 7.00%

Market Snapshot


RESERVE RATIOSCRR 4.25%

SLR 23%

LENDING / DEPOSIT RATESBase rate 9.75%-10.50%

Deposit rate 8.50% - 9.00%

Source: www.bseindia.comwww.nseindia.com

Source: www.bseindia.com

Source: www.bseindia.com23rd November to 20th December 2012

Data as on 20th December 2012

MarketSnapshot

CURRENCY MOVEMENTS


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MarketSnapshot

BSEIndex Open Close % changeSensex 18506.57 19453.92 5.12%

MIDCAP 6597.42 7101.79 7.64%

Smallcap 7057.11 7434.86 5.35%

AUTO 10558.86 11406.99 8.03%

BANKEX 13178.67 14343.78 8.84%

CD 7476.93 7723.79 3.30%

CG 10630.36 10916.42 2.69%

FMCG 5815.39 5949.40 2.30%

Healthcare 7703.04 8198.73 6.43%

IT 5733.43 5637.90 -1.67%

METAL 9801.24 11241.04 14.69%

OIL&GAS 7987.56 8469.24 6.03%

POWER 1920.10 1981.27 3.19%

PSU 7003.98 7276.75 3.89%

REALTY 1869.11 2123.08 13.59%

TECK 3399.91 3405.37 0.16%


Market Snapshot

% CHANGE

IT


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The term BRIC was coined by Jim ONeill in hispaper Building Better Global Economic BRICspublished in 2001. The term is an acronym thatrefers to Brazil, Russia, India and China andis widely used to symbolize the growing shift

of economic power from the G7 economies.Though the growth of these countries has beenoutstanding during the last decade, the recessionarising out of the 2008 crisis and the globaleconomic downturn due to the Euro-zone crisishas cast some doubts on the ability of the BRICnations to maintain the growth rate. Many thingshave changed after the housing bubble, whichled to a global recession in 2008. Russia has beenengulfed in corruption and has not been ableto find a solution to break the business-politics

nexus. India with its coalition government isfinding it hard to balance the power at centredue to multiple scams that are being exposed.China is faltering and the falling growth ratecasts doubt on its ability to handle the presentdownturn.Brazil, on the other hand, has been steady duringthis tough time. Unemployment is low, wagesare rising and the foreign direct investment ispouring in. Many economists are of the viewthat Brazil should be able to grow at 3.5% inthis decade. It is one of the few countries wheredemocracy has brought political continuity andeconomic stability. But, not all is hunky-dory andBrazil has its own set of challenges. The growthwitnessed during the past two decades was aresult of opening up the economy in 1990 and aboost in trade caused due to Chinas demand ofcommodities. However, the Chinese economy isslowing down and this has resulted in a negativeimpact on trade. The cost of doing business isvery high and the complex tax structure acts asa deterrent to MNCs.

Amidst all this, there are two important eventsthat will happen in Brazil. It will host the FIFA WorldCup in 2014 and Olympics in 2016. Only Mexico,Germany and U.S. had such an opportunity to

host two mega events back-to-back. Whilethese events will present organizational andlogistics challenges, they will also offer a uniqueopportunity to showcase a modern and globallyintegrated Brazil. The events will have a deep

impact on the financial and economic climate ofBrazil. The financial effect refers to the budgetarybalance of the host citys organizing committeeand whether the financial costs of hosting theGames can be met by the revenues directlygenerated from the Games events. The economicimpacts will include the overall effect on theeconomy arising out of the increase in tourismand improved infrastructure.Economic Benets

The growing tourism industry results in increase

of revenue for the host nation. But, this canbe termed as short-term effect and no countrywould want to invest billions to promote tourismalone. The more important effect is the increasein exports. Hosting a mega event can be linkedto trade liberalization. In 1955, when Rome wonthe bid to host the 1960 Olympics, Italy startedmoving towards currency convertibility, joinedthe United Nations and started negotiationson treaty of Rome which led to the formationof European Economic Community (EEC). Japanjoined International Monetary Fund (IMF) in 1964when it hosted the Olympics. Spain joined EECin 1986 when it won the bid for 1992 Games.Mexico hosted the FIFA World Cup in 1986 whichcoincides with its trade liberalization and entryinto the General Agreement on Tariff and Trade(GATT). Thus, it appears that hosting a megaevent leads to a boost in infrastructure thatamounts to trade liberalization.The economic impact caused by such megaevents begins from the time the nation wins thebid to host and extends to a few years after the

event. This impact can be classified into threegroups: Pre-Games impact: This includes investmentand other preparatory activities and tourism

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Games impact: With tourism, the infrastructuregets a boost. Temporary jobs are created andrevenue is earned through tickets Post-Games impact: Urban regeneration and in-ternational reputation are some of the long termeffects of hosting a mega eventSince hosting a mega event entails huge costs,financing the event forms the most critical chal-lenge to the host nation. How does a nation fi-nance such a huge event? How can it ensure torecover these costs? Till the Games of 1976 Mon-treal, Olympics was sponsored through publicfunds. But things changed after 1976 Games. Thisevent was financed through public funds and aconsiderable amount was spent on improvinginfrastructure. However, a significant financialdebt was declared from the event. The MontrealGames showed that hosting the event throughpublic funds alone was not a good idea. As a

result, in 1984, when the Games were to be orga-nized in Los Angeles, the citizens voted againstthe use of public funds. This was the first timethat an Olympics was organized through sponsor-ship which later on led to the commercializationof the Games. Though the Los Angeles Games re-sulted in budgetary surplus, the expenditure oninfrastructure was quite low. Thus, the economicbenefits associated with the Games were not perthe expectations expected. The Games of Seoul1988 and Barcelona 1992 proved that a nation

can have huge expenditure on the infrastructureand yet can recover the costs. By this time, peo-ple started laying down more importance on theeconomic benefits rather than concentrating onlyon the financial viability.To consider the economic effects of hostinga mega event, it would not be appropriate tostudy these effects on the developed nations.Instead the effects on similar countries whichinclude China (Olympic 2008), South Africa (FIFAWorld Cup 2010) and India (2010 CommonwealthGames) would present a better picture. The ef-fects of these events are discussed below:Beijing 2008 Olympics

China hosted the Olympic Games in Beijing from8th 24th August, 2008. Beijing was selected to

the 2008 Olympics on July 13, 2001. The gameshad a profound impact on the GDP of China. In1999, the growth rate of GDP was 6.2 % whichrose to 10.5% in 2001 Before the Games the aver-age growth rate was 8.4% which rose to 13.3%during 2001 to 2006. The growth rate of GDP overthe years is given in Figure 1 above.The average growth rate of GDP during the Pre-games years, Games year and Post-Games was13.4%, 13.8% and 13.9% respectively. The growthof per capita GDP in China increased from 5.3%in 1999 to 13.8% in 2005. The growth rate of in-vestment increased from 10.2% to 23.7% in 2006.Huge amount of employment was created owingto increase in investment. The Games generateddirect employment for 2,788 thousand workers.Figure 2 shows the employment figures of pastGames.The profit that China earned from hosting this

mega event was 16 million dollars. However, thisfigure should not be considered as the actualbenefit from hosting the event. This figure givesonly the difference between revenue in the formof ticket sales, broadcasting rights, etc. and ex-penditure on infrastructure. The long term ben-efits arising out of the improved infrastructureand international reputation are not evidentfrom this figure. To conclude, the Olympic Gameshelped China show its ability to manage a megaevent and opened up new avenues for growth

and investments.South Africa, 2010, FIFA World CupThe FIFA World Cup took place in South Africafrom 11th June to 11th July 2010. This was thefirst time that a World Cup was being hosted byan African country. The total amount spent ontourism due to this event is estimated to haveboosted the economy by USD 475 million. How-ever, the event posted a loss of USD 6.6 billion tothe national budget. Thus, a question that needsto be asked is whether the economic benefitsjustify this immense loss or not?The total number of tourists that visited duringthe event was 309,554. It is likely that the tourismin South Africa will get a boost as 90% of the visi-tors interviewed in a survey may visit the place

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1999 2000 2001 2002 2003 2004 2005 2006

Growthrate ofGDP (%)

6.2 10.6 10.5 9.7 12.8 17.7 14.5 15.1

Source: National Bureau of Statistics of China, China Statistical Year book 2006

Fig 1: Growth Rate of GDP in China


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again. Though the event boosted the economicgrowth by 0.5%, much of it was caused due tothe Government expenditure. Thus, the event led

to redirection of national wealth and not creationof wealth. Employment was also impacted by theevent. Almost 695,000 jobs were created in theyear 2009 and most of them sustained through2010. However, not many of these jobs were per-manent and hence the surge in employment didnot last long after the event.Though theevent wassuccessfullyorganized,

the hugeloss hasraised manyquestions. Giv-en the loss, was itpractical to organize suchan event in a developingcountry like South Africa?How much should the economic ben-efits be to offset this loss? Was this loss createddue to operational and financial inefficiencies?Only time will tell if the economic benefits are

as expected.India 2010 Common Wealth GamesThe Common Wealth Games were held in Delhifrom 3rd - 14th October, 2010. India is the thirddeveloping country to host this event after Ja-maica in 1966 and Malaysia in 1998. Like othermega events, this event too had an impact onthe social and economic dynamics of the nation.The Organising Committee claimed that the eco-nomic contribution to Indias GDP is USD 4.94 bil-lion during a four year period (2009-2012). It is

estimated that close to 2.47 million job oppor-tunities were created during this period. A pro-found impact was seen on the economy of Delhiwhich witnessed a high growth rate of around9% during this period. The Government of India

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took additional efforts to promote tourism by lib-eralisation of visa-on arrival and permitting 100%FDI in tourism. One of the major bottlenecks for

this event was the accuracy of the revenue pro-jection. The projected revenue in July 2008 wasUSD 410 million. However, out of the total com-mitted revenue of USD 157 million by OrganisingCommittee, only USD 101.5 million was the netrevenue generated. After deducting the revenue

ge ne ra ti on cost, the totalreve- nue amounted

to only USD40 million.The event

was alsoscarred bythe massive

c o r r u p t i o nwhich resulted

in the arrest of a seniorpolitician.

The long term benefits ofhosting this event on India and

particularly Delhi which hosted this event re-mains to be seen.Conclusion

The global economic climate is gloomy due tothe Euro-zone crisis and a slow U.S. recovery. Theinvestment in the developing countries has driedup and countries are trying to woo the investorsby going an extra mile. These events will serveas a platform to boost the economy of Brazil. Anefficient execution of events, check on financialviability of investments, judicious use of publicresources and public policy reforms will helpboosting the trade and tourism. Thereafter, it willdepend on how Brazil uses this opportunity and

creates a sustainable growth and developmentmodel.

Los Angeles1984

Seoul1988

Barcelona1992

Atlanta1996

Sydney2000

Beijing2008

IncreasedEmployment

(in thou-sands)

25 336 120 90 1577 2788

Source: National Employment Bureau of China, China Statistics year book 2010

Fig 2: Employment gures for past Olympic games


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2% of GDP in the year 2012-13 and bring it down toless than 1.75% over the next three years. Figure 1shows the trend of various subsidies for 5 years.

The food subsidy bill of India in the fiscal year 2012-13 has already swelled to over Rs.101879 crore in

the first six months, around 36% more than thebudgeted estimate. This could seriously jeopardizegovernments plan to rein the fiscal deficit at 5.1%of GDP.

As far as the efficiency of present measures againstpoverty alleviation is concerned, it can be said withreasonable confidence that they arent serving theirpurpose well. Hence, the recent proposal is theculmination of several factors: (a) ballooning fiscalcosts, (b) the manifold distortions resulting fromthe subsidies, (c) the successful examples of Cash

transfer programs around the world, particularlyin Latin America, as a means to address povertyand improve social welfare of the poor, and (d)institutional and technological changes within India,particularly the on- set and rapid expansion of theAadhar program which aims to give every Indian abiomarker-based unique identity and Swabhiman,under which every Indian is` expected to haveaccess to a bank account, bringing, for the firsttime, half of Indias population access to financialinclusion.

Cash Transfer Schemes: A Boon for India?

Cash transfers will replace forty two differentwelfare schemes and cover the entire country. Theadvantages of Cash transfers are quite evident.Direct Cash transfers will eliminate the long chainof intermediaries and subsequently reduce the costof distribution to a substantial extent. This willprove beneficial for both the people as well thegovernment.

According to P. Chidambaram, the cost of transferring

one rupee to the pockets of the beneficiaries ispresently three rupees for the government. Therest is spent on administrative expenses, wasteand corruption. Cash transfers will eliminate theintermediaries, hence reducing the corruption and

TeAM NIveshAk

Anchal Khaneja & Gourav Sachdeva

All men can see these tactics whereby I conquer,but what none can see is the strategy out of whichvictory is evolved.

-Sun Tzu

The apparent swiftness with which the Indian

government has acted on the introduction of CashTransfers (CT) in India is perhaps unparalleled,definitely very rarely observed to say the least.Are the minds at helm of affairs at present sooverwhelmingly sure of the results of the newpolicy that they couldnt resist delaying it anymore,is something else at stake here or are they justfollowing what has undoubtedly become the latestfad of the international development industry, asthe preferred strategy for poverty reduction (Theyare now being cited in many places as the solution

to the problem of poverty)? In this cover story ofNiveshak, we take a holistic view at this rathermuch-debated topic of Cash transfers in India.We begin by having a look at the present scenarioof the welfare schemes, go on to establish theneed for CT in the country and then look at theadvantages and disadvantages of the same. We willalso critically examine some of the very successfulimplementations of Cash transfers around theglobe.

Where we stand today?

In the fiscal year 2010-11, Government of Indiasexpenditure in subsidizing the retail prices ofdiesel, kerosene, LPG and gasoline amounted to awhopping Rs. 43904 crore (USD 9.6 billion) and itgrew by 26.7% in the year 2011-12. Food subsidiesprovided by the central government increased byover 300% in a period of six years between 2006-2007 and 2011-12. The same has seen a 25-foldincrease in a span of 21 years.

The Union Budget 2012-13 attributed the deterioration

of fiscal balance in 2011-12 to this steep increase insubsidies and pointed out that such a high level ofgrowth in subsidies is not sustainable in the longrun. The Budget also pointed out the Governmentsintention to maintain the level of subsidies under

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similar programs existing in the South Americancountries. These countries are among the highlyurbanized countries in the world with more than70% of the population living in cities. Corruptionis comparatively low, as is gender discrimination.They have highly stable welfare services. On the

other hand, in India, the basic infrastructure forwelfare services is collapsing and hence any cashtransfer policy can have disastrous results.

The CT schemes of Brazil and Mexico are quotedas examples by the government. But it should bekept in mind that only 5% of the population ofthese two countries is below the poverty line andthe Indian figure stands at a whopping 46%. Thus,their system which caters to only a small numberof beneficiaries is unlikely to be viable in India.The consequences should, therefore, be taken

into account before deciding to operationalize anysystem of Cash Transfers.

It is important to note that the Supreme Court ofIndia has defined social security, food and nutritionas the basic human rights and these cannot becurtailed by below poverty line (BPL) eligibilityconditions. Cash Transfers limit these basic rights.They can be successful only in places where thegovernment bodies are capable and influential.Whereas in India, the political system is weak andhence the Cash Transfer schemes might prove

completely incapable of meeting their objectives.or a Bane?

However benevolent be the intentions behind thenew scheme, there are two pressing questions thatdemand urgent answers. They are If cash transfersare put in place, consumers will be on the mercyof highly competitive markets alone; who then,will ensure that any price increase will be suitablycompensated for in the new deregulated marketsfor all goods? And how will the government makesure that the transfers actually happen to those

who are the intended beneficiaries? To worsen thematter, is the fact that Cash Transfers are not new toIndia. There are already a number of Cash Transferprograms ranging from targeted unconditionalsocial security programs to the ones designed tochange societal behavior towards girl child. Indeed,while its proponents may not like the designation,Indias flagship National Rural EmploymentGuarantee Scheme is at heart a conditional CashTransfer program. The hiccups experienced in theseprograms are not a matter to be explained here.

Situations can only get worse if scales increase.

To answer the first of the two concerns, it can beargued that Cash Transfer systems can simply beindexed to price indices (for example, in the case

administrative burdens. The Direct Cash transferScheme will have the potential to phase out thetremendous paperwork and consolidate them underone identification requirement of Aadhaar UID.

To illustrate, the rationale for subsidised kerosenewas to provide cheap fuel where electrification wasnot prevalent. But, it is available at subsidised priceseven in states where electrification is widespread.Kerosene is hardly used for cooking purposesnow-a-days both in rural as well as urban areas.However, it has become a more important fuelsource for lighting. There are presently 70millionhouseholds (mostly rural) in India that usekerosene for lighting purposes. While the subsidy

is intended to shield the poor households from thevolatile nature of prices and provide a stable supplyof fuel, it has created a large black market whereincheap kerosene is diverted and mixed with petroland diesel. In such a scenario, if the governmentcan successfully execute a Cash transfer programthat provides cash equivalent of the subsidy whilesimultaneously raising the prices of kerosene, it willhave considerable effects on reduction of pollutionlevels and criminality. The cost to the governmentwill substantially reduce due to better targeting.

India requires completely different infrastructure inorder to make Cash transfer schemes successful inIndia. The ration shops that deliver subsidies bymeans of low priced essential goods would no longerbe relevant and a cash equivalent of the subsidieswill have to be distributed by a proper network ofbanks. But the requisite banking facilities do notexist in the Indian villages, majority of beneficiariesare illiterate and, in spite of Aadhaar, may nothave been properly identified. Obviously, it is notpossible to have a perfect system in place right

from the start. The system will get refined once theschemes come into operation.

Where Cash transfers can work?

The Indian initiative is more or less influenced by

Fig 1: Subsidies trend in India in 5 years

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Bolsa Famlia in Brazil, both types of errors remain

high. An evaluation by the International Poverty

Centre of the United Nations Development Program

(UNDP) showed that 70% of the poor were excludedfrom the benefits of Oportunidades, and 59% of the

poor were excluded in Bolsa Famlia. In contrast,

Bolsa Famlia was found to have a higher inclusionerror than Oportunidades: 49% of all beneficiariesare non-poor in the former program but only 36%

are non-poor in the latter. India is already infamous

for its leakages in PDS and other schemes. It is

illogical in the very first place to imagine that cash

transfers will solve this problem; how simplerand easier it will be for those who

benefit from such leakages to divert

cash, rather than goods that have to

be stored and resold.

Another important facet ofthe cash transfer schemes

that seems to be missing

from the governments

current point of view isthe sunset or the exit

clause. In every case, cash

transfer proposals must have

a well-worked out temporal

dimension. We must carefully consider possible exitoptions under which cash transfers might wane or

cease, as beneficiaries status changes, programobjectives are met, or critical effects urge a rethink

of the direction of the strategy and its interaction

with other priorities. Therefore, unless sunsetclauses or incentives are built into the cash transfer

programs that incentivize beneficiaries to move out

of them, there will be a natural lock-in effect. Are

we witnessing another reservation system in the

making?

The Verdict

All said and done, cash transfers are definitely aneffective tool in poverty alleviation and bringing

social equality in an economy. What is probably

wrong with them in the Indian context at this

point of time-is the time itself. India still needs to

overcome a number of challenges and do a lot ofgroundwork before it can embrace cash transfers in

its system.

It is imperative that the government focusses onother pressing issues at hand and plug in the

loopholes existing in the system prior to embarking

on the journey to cash transfer schemes. If theresults of the Cash transfer Pilot Project in Rajasthan

are anything to go by, we believe that this is theright way to go for India.

of food items, to the price index for the foods inquestion). But anyone familiar with the lags inpublic response to price changes for examplein the setting of minimum wages, and in thedetermination of the national wages under the

the Mahatma Gandhi National Rural Employment

Guarantee Scheme (MNREGS) will immediatelyunderstand that this is an excessively optimistic,even utopian, assumption in the Indian context. Torevert to the food example once again, in contextof the high food inflation rates of between 15%and 20% per year experienced in India in the past,even within half-yearly revisions to the amountof a predefined transfer, there wouldbe considerable effective loss to thedesignated beneficiaries.

Let us get this straight from

the horses mouth. A survey,conducted by a group of NGOsincluding the Right to FoodCampaign in Delhi threw up thisrather audacious fact 99%of slum women prefer foodrations rather than cash transfers

or coupons specified for a specificvalue. The 593 women from 14slums interviewed in this survey also feared thatcash receipts could get spent on other householdpriorities or immediate needs of the moment, be itfor a health emergency or a celebration, if not onliquor, etc. They therefore wanted a strengthenedPDS that functions well, preferably run by self-helpgroups or co-operatives. To support their view, astatement from Nilekani interim report reads,The Task Force does not recommend substitutionof public provisioning by the State. Instead itrecommends a solution whereby the subsidies thatare being provided by the State now can be moreefficiently provided to the intended beneficiariesdirectly. It complements public provisioning by theState, rather than supplanting it.

Moving on to the second question that ofidentification of target beneficiaries gives ussome more insights about potential flaws of theproposal. The very process of identification cangenerate some well-known errors - Type I errorsof unjustified exclusion of the genuinely poor andType II errors of unwarranted inclusion of the non-poor. Moreover, the possibility of such errors is

inherently higher for a cash transfer program thandelivery of food or other goods because of lack of

any incentive to opt out of such a program. For

example, in the most widely quoted success stories

of cash transfers, Oportunidades in Mexico and

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development. In addition to the traditional roles, RBIalso plays a very critical role in development of thecountry by revising Monetary Policies. The centralbank of the country establishes a suitable interest

rate structure to manage the investments in thecountry. The rates also decide the money supply inthe market, so, by changing the rates the centralbank manages inflation and growth.

Conict of Monetary policy and Fiscal Policy

The conflict between monetary policy and fiscalpolicy arises because of the difference in the goalsof the Government and the central bank. Whilethe aim of the Government is high growth and lowunemployment, the main aim of the Central Bank isto regulate money money supply and thus stabilizeprices.

The conflict of interest between monetary policy andpublic debt management lies in the fact that whilethe objective of minimizing market borrowing costfor the Government generates pressure for keepinginterest rates low, compulsions of monetary policyamidst rising inflation may necessitate a tightermonetary policy stance. Therefore, the argumentin favour of separating debt management frommonetary policy rests on the availability of the

effective autonomy of the central bank, so that it isable to conduct a completely independent monetarypolicy even in the face of an expansionary fiscalstance of the government.

Sometimes the conflict between the two arises overthe usage of the foreign reserves of the country.While the Government intends to use the reserve tofinance its projects, the central bank wants to keepit as a reserve for safety and liquidity purposes.

Relation between the RBI and the Government

of India: History

Post-Independence

The role of government after the independence wasto guide the economy which was highly stressed.The functions of RBI also became diversified as it had

The nature of functions discharged by the centralbank and its relations with the functions dischargedby the central government has been debated for along time. Together the central bank and the central

government of a country are responsible for puttingthe economy on the path of prosperity and success.However, due to the complexity of the relationsbetween the functions performed by these twoentities, there can be instances when central bankand the government are at odds against each other.Since the time India gained freedom, socialist ideaswere promoted and the role of government in guidingthe economy was stressed upon. The objective was topromote balanced growth and also to take initiativesfor the welfare of the people. India being a countrywith a huge size, vast amount of natural resourcespromised a huge scope for development. However, itwas not until 1991 that effective economic reformswere introduced in the country which placed Indiaon the path of high economic growth. Since then,the role of the central bank, that is, the ReserveBank of India has widened in scope. In the lights ofthe developments in the Indian economy after 1991economic reforms and the major economic eventssuch as the 2008 recession and the Euro zone crisis,we will analyse the relationship of the Reserve Bankof India with the central government, with a focus

on their existing relationship.Role of Government

The role of government in the economy is tomaintain growth and generate employment for thecitizens of the country. The government in order toachieve its objectives tries to mould the following inan economy:

1) Pace of economic activity

2) Maintain steady growth

3) Maintain high levels of employment

4) Maintain price stabilityRole of Central Bank

In developing countries, central banks play a veryimportant role in not only regulation but also

MDIAshish Khare & Deependra Kumar

GovernmentofIndiaand RBI:

An Evolving

Relationship


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basis points between 2010 and 2011. Figure 1 shows

the variation in Repo rate & Inflation over the last

3 years.

Despite these actions, inflation continued to remain

high. Analysis of the sector composition of growth

reveals that the growth moderation during 2008-12

was driven largely by manufacturing and agriculture

sectors. The sources of inflation during post-crisis

period suggest that the increase in inflation was

contributed by more than doubling of food price

inflation to 11.8 per cent during 2008-12. A major

factor from the demand side contributing to the

persistence of food price inflation, which caused

generalization of inflation and fuelled inflationary

expectations, was the sharp rise in rural wages.

While RBI was trying to tame the inflation,

government on the other hand was trying to prevent

the country from recession by giving many benefits

to the mass to increase consumption and hence

to take part in nation building. Post-independence,government triggered the economic growth throughlarge public investment which was facilitated byaccommodative monetary and conducive debtmanagement policies. RBI played a crucial role offinancing the government debt by monetising andmaintaining interest rates artificially low, so that

the cost of borrowing for the government remainscheap.

By the end of the 1980s, a fiscal-monetary-inflationnexus was increasingly becoming evident wherebyexcessive monetary expansion on account ofmonetization of fiscal deficit fuelled inflation.

Post 1991

After 1991, despite the fact that fiscal compressionwas on its way and efforts were made by RBI inmoderating money supply during the early 1990s,

the continuance of the ad hoc Treasury bill impliedthat there could not be an immediate check on themonetized deficit. In order to keep a check on theunbridled monetisation of fiscal deficit, the firstargument between RBI and the Government of Indiastarted in 1994 to set out a system of limit for thecreation of an ad hoc Treasury bill within three years.Later a supplemental agreement was made in 1997to completely phase out the treasury ad hoc bills.In 2006, under the provisions of FRBM, participationof RBI in primary auctions of government was alsostopped.

Post 2008 recession, Indian economy struggled tokeep inflation low, and there were fears that thecurrent high levels of inflation may become thenew norm for the Indian economy. To deal withthe inflationary pressures, the RBI raised the reporate by 375 basis points and the CRR ratio by 100

Fig 1: Variation of Repo rate & Ination over hte last 3 years

Fig 2: Relation between Repo Rate and the economic growth rate for the last 4 years.


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increase the growth. The difference in the goals ofthe two entities has recently become public whenGovernment asked the RBI to reduce the interestrates so that the growth is not hampered due to

the monetary policy. Figure 2 shows the relationbetween Repo Rate and the economic growth ratefor the last 4 years.

A look at the US Economy: Relation between

the Government and the Federal Reserve

The low growth in the US is a major concern forboth government and the central bank. The grave

problem of liquidity trap is on the verge and a goodmix of fiscal and monetary policy is what is neededin this case. While the central bank has kept all therates low, the growth targets are still not achieved.

Central bank also needs to ensure that the rate willbe kept low past the crisis. On the other hand, fiscal

policy is more effective during these times becauseit doesnt promise anything past the crisis, but itis difficult to sell the stimulus packages. There arelimitations to both kind of policies which make itall the more important for both the government and

the central bank to hold hands. The best strategy isto campaign on both the fronts of the policies andthat is what has been implemented in the US. While

the government is ensuring that austerity measuresare avoided, the Fed has made clear that the rateswill not be hiked until inflation attains high levels.

Conclusion

As much as we try to blame the cost push asbeing the prime factor behind this persistent

inflation , there is a growing need to realize the factthat a sound fiscal situation ensures that inflationis contained . A country which has strong fiscal

fundamentals hardly finds itself struggling to keepinflation low.

What also needs to be realized is that, even if themonetary policy framed by the Reserve Bank of Indiais set to keep the current levels of inflation low and

the fiscal policy aims to reduce revenue collectionfrom people through reduced tax collections, moneyfinancing will eventually be required by the centralgovernment. This will mean a dependence on

borrowing and hence an upward push to the costsfor the government leading to higher inflation onceagain. Hence it is of great importance for both the

monetary and fiscal policy to be in tandem witheach other.

It is in this context today that the RBI and the central

government are in a conflict with each other. Thereare concerns about the lower expected GDP growth

rate by the GOI and the RBI is concerned about thepersistent high inflation.

An important area of focus today thus has been the

containment of the fiscal deficit. If we look at theRBI claims, it wants the government to reduce itsexpenses on subsidies rather than increasing thetaxes so as to contain the fiscal deficit. A deteriorating

fiscal situation has also posed dangers of creditrating downgrade from the credit rating agencies.This will have direct implications on the investor

confidence and will pose a big threat to putting theeconomy back on the trajectory of higher growth.The government has responded to this situation byshowing firm resolve to improve the fiscal situation

through a number of policy initiatives. However thegovernment blames RBI for playing it safe by notreducing the lending rates and only altering the CRR

rate in some of the recent monetary policy reviews.

However, RBI has its own problems which haveforced it to maintain a tighter monetary policy. The

depreciating rupee, euro zone crisis, rising oil priceshave forced RBI to keep the interest rates high. As

much as it appears that it will help to contain theinflation we see that the food inflation has remainedmore or less at the same level. This is because of the

fact that RBI is trying to control inflation by focusingon demand push inflation whereas the currentinflation levels have a lot to do with the cost pushinflation. Thus RBI policy is going wrong here and

hence needs corrective actions. However the factthat the rupee has undergone serious devaluation

over the course of past one year and the oil priceshave remained stubbornly high, lowering interest

rates poses risks of worsening this situation.

It is thus important for both the RBI and thecentral government to work in accordance witheach other. Rule based fiscal policy by the central

government will become increasingly important toafford the space for monetary policy to contributeto macroeconomic stability. Fiscal prudence by thecentral government to alleviate resource constraints

by boosting domestic saving will be crucial for

raising domestic investment rate. In addition to this,RBI will also have to take certain strong measures to

infuse more liquidity into the system by lowering theinterest rates keeping in mind the fact that the majorcause for high inflation has not been the demandpush inflation. The quicker this important realization

occurs to both the central and the Reserve Bank ofIndia, quicker will be the improvement in Indiasgrowth prospects and in the relationship between

the central government and the RBI.



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1914-1918

Finistor

y

The United States was actively involved in World WarI for only 19 months i.e. from April 1917 to November1918. During this period, their mobilization of theeconomy was extraordinary. An estimated 4 million

Americans served in the armed forces, and thusthe U.S. economy had to turn out a vast supplyof ammunitions and raw materials. While enteringthe war, Americans knew that the price of victorywould be extraordinary. What, then, encouraged theUnited States to enter? What economic forces wereresponsible in bringing about this development?

Why did United States enter the World War I?

One social factor which has always been pointed outis that Americans had stronger ties with France andBritain (Allies), than with Austria and Germany. By

1917, it became clear that France and Britain werenearing exhaustion and there was considerablesentiment in the United States for saving thetraditional allies. However, the main trigger wasthe bombing on US trade vessels by the Germansubmarines. The loss of several American tradevessels and 155 Americans on board was a key factorin President Wilsons verdict to break diplomaticrelations with Germany and declare a war.

Effect on Economic Trades

Looking at the economic trades with Europe, theUnited States exports to Europe reached $4.06 billionin 1917 from $1.48 billion dollars in 1913. If U.S. had

stayed out of the war, all trade with Europe wouldhave been cut off. Assuming the resources engagedin the lost trades would have been reallocated toother purposes such as producing goods for exportsfor non-European countries or for domestic market,the calculated loss in output would have been $2.03billion in 1917 which was 3.7 percent of GNP in 1917,and only about 6.3 percent of the total U.S. cost ofthe war.

Armed forces of United States

The area of paramount importance before the entryinto the war was the mobilization of the armedforces. When the U.S. entered the war, the army stoodat 0.2 million, which was hardly enough to have aninfluential impact in Europe. However, by May, 1917,a regulation was imposed and the numbers wereenlarged rapidly. Initially, a figure of 1 million wasunder discussion in the corridors of U.S. governmentbut soon it touched a new high. Overall the size ofarmy grew to 4.7 million. The increased size of the

TeAM NIveshAkNirmit Mohan

Fig 1: GNP Growth of US Economy during

World War I


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army demanded: guns and ammunition, means of

transport, training schools, food and clothing etc.The U.S Naval forces also had to be expanded to

protect the American shipping and the troop

transports. Tenders were immediately floated

demanding these facilities from the private sector.

This resulted in an exponential rise in the Federal

Spending from 0.47 billion in 1916 to 8.45 billion in

1918. The latter figure accounted to over 12% of GNP.

The above amount excludes spending by allies and

other wartime agencies most of which was funded

by loans from the United States.

Industrial Growth during World War I

It is evident that the increase in the armed forces did

not prove to be an unmanageable burden for the U.S

economy as the total labor force rose to 44 million

in 1918 from about 40 million in 1916. The real wages

rose in the industrial sector during the war, perhaps

by 6% or 7% , and this increase accompanied with

the ease of finding work was adequate to draw manymore workers into the labor force. Although, theagricultural labour did drop slightly to 10.3 millionfarmers in 1918 from 10.5 million farmers in 1916 but,it was felt that agricultural farming included manylow-productivity workers which became evident by asustained output of the agricultural sector. Instead,the all-important category of food grains showedrobust increase from the year 1918 onwards.

Figure 2 shows the total industrial production (anindex of steel, copper, rubber, petroleum etc.) and

the monthly production of Steel from 1914 to 1920. Itcan be inferred that the U.S. had built up its capacityto turn out these quintessential raw materials duringthe years of American neutrality when British andFrench Governments were buying its supplies. TheU.S. then merely maintained the production of thesematerials during the years of active U.S. involvement

Fig 2: Comparison of Total Industrial production and Steel during 1914-1920

Fig 3: Performance of NYSE during World War I

100

90

80

70

60

50

40

30

20

10

Armistice

1913 1914 1915 1916 1917 1918 1919 1920

Nominal Prices Real Prices

Outbreak of War US Entry

The Stock Market, 1913-1920



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y

and concentrated on turning these materials into

munitions.

Performance of Stock Market during World

War I

Figure 3 provides some insight into what investors

perceived about the performance of the U.S. economy

during the war era. The dark line shows the S&P/Cowles

Commission Index, while the dotted line shows thereal price of stocks (adjusted by the consumer price

index). When the war started, the New York Stock

Exchange was shut down in anticipation of panic

selling for about 6 months. After the market reopened

in January 1915, it followed an upper trajectory as

investors anticipated that the United States neutrality

would profit. But later, it followed a long downslide

when tensions built up between the United States

and Germany (in 1916). The rally continued after the

United States entered the war in 1917. A second rise

was witnessed at the start of the year 1918, whenan Allied victory began to appear conceivable. This

rise continued and picked up momentum after the

Armistice in 1919. But in real terms, this rise was

not sufficient to counterbalance the rise in consumer

prices. Thus, though many economists say that the

war is good for the stock market, but the records for

World War I narrate a more complex story.

Financing the War

A question which will arise in everyones mind is

Where did the funds come from to manufacture all

the ammunition and other requirements?

The possible options during the World War I to raise

money were; raising taxes, borrowing from the public,

and printing money. The U.S government did not give

much thought to printing money due to sacrosanctgold standards. Thus, the real choices available wereeither raising the taxes or borrowing from the public.Most economists at the time of World War I believedthat raising taxes was the best option with the U.S.Government. Thus, in October 1917 Congress cameup with War Revenue Act to call for higher taxes.This act established new excise, excess-profit, and

luxury taxes in addition to increase in personaland corporate income tax rates. The tax rate for anincome of $10,000 with four exemptions was raisedto 7.8% from 1.2%. For higher incomes of $1 millionthe tax was raised to 70.3% from 10.3%. Thesetaxes increased revenue receipts to $4.3 billion in1918 from $0.93 billion in 1916 whereas the Federalexpenditures increased to $15.5 billion in 1918 from$1.33 billion in 1916. Thus, a huge gap had openedup calling for public borrowings too.

Short-term borrowing was introduced as a stopgap

arrangement to reduce the pressure on the Treasuryand the danger of a surge in short-term rate.However, long-term bonds were later pitched in bythe Treasury under the name of Liberty Bonds.These bonds were made attractive for people fallingin high tax bracket by tax-exemptions. The 1st issuewas a 3.5% coupon 30 year bond callable after 15years. In all, there were three issues of Liberty Bondsand one issue of short-term Victory Bonds after thepeace agreement, thereby raising over $20 billionfrom public for the war effort.

Once the money began flowing and contracts forammunition were issued, the government mobilizeda gamut of agencies to control the economy duringthe World War I.

A Food Administration board was appointed to

Fig 4: Revenue and Expenditure of US Government during 1916-1920


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control the agricultural production and ensure a fairdistribution among the U.S. civilians, Armed forces,and the Allies at a fair price.

A Fuel Administration board was constituted to

look into the distribution of Bituminous Coal, as avariety of factors led to Coal Shortage in 1918. Thisboard reacted by setting the price of coal, margins

of dealers, mediated disputes in the coalfields, andworked with the transporters to reduce lengthyhauls of stocks.

A Railroad Administration was appointed by

nationalizing the railroad as severe congestions inthe network were stalling the movement of wargoods and coal.

Other boards included the War Labor Board to

settle labor disputes; War Shipping Board to buildnoncombatant ships; the New Issues Committee tovet private issues of stocks and bonds etc.

Long-run Economic Impacts

The war left a number of long run economic legacies.

Firstly, the finances of the U.S Federal government

were perpetually transformed by the war. Though taxincreases were scaled back by the year 1920, therates were still kept high to pay for higher capitalexpenditures, mainly due to interest on the nationaldebt.

Internationally, economic position of the United

States was transformed dramatically from a debtor to

a net creditor. In 1914, U.S investments abroad stoodat $5.0 billion against the total foreign investmentsof $7.2 billion Thus, Americans being a net debtorof $2.2 billion. But by 1919, U.S investments abroadhad risen to $9.7 billion against the total foreigninvestments of $3.3 billion leading to being a net

creditor to the tune of $6.4 billion. This eventuallyled to the shifting of the center of the world capitalmarkets from London (Bank of England) to New Yorkafter the war.

December 2012

FIN-Q Solutions

NOVEMBER 20121. Liquidity

Preference

2. Marginal StandingFacility

3. Nanjing MotorCompany, China

4. Bill S. 2059, knownas the Paying aFair Share Act of2012

5. K.C.Pant

6. X-John J. MackY-Morgan Stanley

7. X -Citigroup,Y -AmericanInternationalGroup(AIG) andreverse stock split

8. Kagi Chart

9. Game Theory



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Finsig

ht

Banking in India

The Indian banking system started with the

Government of India establishing three presidency

banks in India, namely, Bank of Calcutta (1806), Bankof Bombay (1840) and Bank of Madras (1843). Thesethree Presidency banks were subsequently merged

into the Imperial Bank of India in 1921- which isnow the State Bank of India. Towards the late 19thCentury some banks like Allahabad Bank Ltd., Punjab

National Bank, Bank of India Ltd. and other cameinto picture. These, along with some other majorbanks were nationalized in 1969 and 1980.

Banks which were not nationalized in these years forinstance, Bank of Punjab, City Union Bank, ING Vyasa

Bank etc were called Private Sector Banks (PSBs),which later came to known as old private sectorbanks after some new banks (now known as newprivate sector banks) like HDFC, ICICI, Axis bank etc

came into foray, following the economic reforms of1990s.

Private Sector banks

The Private Sector Banks of India are the most lucrativetarget for domestic as well as foreign investors owingto their remarkable progress in recent years. More

aggressive by nature, these banks have been ableto outperform their Public Sector counterparts withrespect to most key ratios like Net Interest Margin,Credit/Deposit ratio, return on assets (RoA) while

maintaining better credit quality.

Asset Quality

Adding to the slow economic growth and growingfood inflation, are the global concerns of fiscal cliffoutstanding at the end of the year that is likely to

have a strong impact on the performance of thebanks, anticipation of the analysts and decisions

of investors. While aggressiveness is importantfrom the credit growth perspective, credit quality is

what, according to most equity analysts, separatesthe winners from the losers in these testing macro-economic conditions of Indian Economy. While RBI

statistics over the past 3 years show significant

improvement in the net NPA of new private sector

banks, including the most aggressive ICICI bank

which saw its NPA coming down from 1.7 in FY2010

to 0.73 in FY2012, the NPA of PSU banks showed

an increasing trend, with the current average of

1.53. Increasing percentage of sub-standard assets,

relatively higher exposure to Gross NPA heavy

sectors, as revealed by their loan portfolio, high

debt restructuring, low NPA coverage, and thinning

capital cushion (Tier-1 Capital, less stressed assets)are some of the major reasons supporting the

assumption that the asset quality headwinds will

persist in the PSU sector. Exposure of PSU banks to

sensitive sectors as a percentage of overall exposure

vGsOM, IIT khArAGpur

Sinjana Ghosh

Fig 1: Substandard Asset Percentage (2007-2012)

Fig 2: Gross NPA percentage (2007-2012)


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Finsight

declined marginally to 28.7% v/s 29.2% in FY11.

Capital Ratios are the indicators of how risky abanks balance sheet is and the degree to which

the bank is vulnerable to an increase in bad loans.Banks with a higher share of Tier I Capital are likelyto outperform those with a lesser share. Here, thenew private banks like Yes Bank; HDFC shows aconsistently increasing trend while PSUs are on thedecline.

Protability and Effciency

Macro-economic factors largely determine theprofitability of various sectors forming a part of thebanks loan portfolio. New private sector banks havebeen able to maintain their credit growth despite

slowing corporate spending cycle. On the other hand,larger exposure to priority sector and low-intereststudent loans has led to a decrease in profitabilityof PSU banks. Asset quality dominates interestrate declines in driving banks stock performances.Statistics suggest that the new private sector banks

have not only been able to maintain a better NIM

but also increased their non-interest income through

other business like Credit Cards, Trade Finance, and

other fee based services.The private sector banks show strikingly stronger

growth in the average spends by their credit card

customers compared with the PSU banks.

Another interesting ratio is the term loan to total

advances. Term loans, unlike demand loans are of

long term, high value, and chargeable at floating

interest rates, hence are more profitable and

sustainable assets than latter. These loans are

usually done in conjunction with specialized financial

institutions which have greater contribution, hence

greater charge on the security. Some new private

sector banks like ICICI Bank, Kotak Bank, have taken

full advantage of their presence across all sectors of

financial services, to grant more term loans, thus

increasing their profitability. Though the old private

banks have performed remarkably well in terms ofreturn on advances, given the smaller share of termloans and their limited reach across the country,sustaining the margin over the quarters has been achallenge.

Indicators of different groups

Valuation Ratios

Strong core operations and robust asset qualityof Private Banks is evident in their premiumvaluations relative to the state-owned banks.

Fig 3: Loan Portfolio of Different Banks

Bank Group CAR (Tier I)2011

CAR (Tier I)2012

CAR (Tier II)2011

CAR (Tier II)2012

SBI & Associates 8.71 9.38 4.23 3.88

Nationalized Banks 9.01 9.05 4.45 3.85

Old Private Banks 15.35 12.46 1.73 1.73New Private Banks 12.27 12.08 4.01 4.12

Table 1: Capital Adequacy Ratio of different Banks

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Feb-11

Apr-11

Jun-11

Jul-11

Sep-11

Nov-11

Dec-11

Feb-12

Apr-12

May-12

Jul-12

Aggregate PSU Private

Fig 4: Average spend by credit-card customers bank-group wise



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Analysts foresee that slowing credit growth and

degrading asset quality is likely to persist in the

coming quarters for public sector banks, while retail

assets focus, improving asset quality and robustfundamentals would be the key driving factors for

Private Bank Stocks in the capital markets. Despite

fluctuations post US elections, mutual funds across

the nation, are showing their preference towards

the large-cap and mid-cap private banks over giants

like SBI.

Finsigh

t

Success Strategy of the new private banks

The historical decision of liberalization of banking

sector coupled with a steady economic growth ofIndia, paved way for the new generation tech-

savvy banks which leveraged on their superior

technology and promotional expertise to build a

strong foothold in India.

Marketing

Promotion of banks were limited to newspaper ads

Bank Groups

Net Interest

Margin

Operating

Profits/ Total

Non-Interest

Income/ Total

Term Loan/

Total

Advances

Profit per

employee

2011 2012 2011 2012 2011 2012 2011 2012 2011 2012

SBI & its

Associates2.96 2.90 2.17 2.08 1.05 0.92 55.29 52.20 0.58 0.55

Nationalised

Bank2.75 2.58 1.95 1.88 0.83 0.78 56.77 56.45 0.7 0.7

Old Private

Bank

3.08 2.96 1.89 1.88 1.02 1.01 47.88 47.36 0.52 0.58

New Private

Sector Banks3.32 3.19 2.56 2.42 1.73 1.67 70.68 71.28 0.99 1.04

Key Valuation

Metrics

SBI ICICI HDFC AXIS YES PNB ING VYSYA

2011 2012 2011 2012 2011 2012 2011 2012 2011 2012 2011 2012 2011 2012

Book Value per

share(INR)1014 1215 481.3 527 118 128.7 452.8 541 109.3 132.5 632.5 779.4 208.4 258.1

EPS(INR) 130.2 174.5 25.2 24.2 23.8 27.18 82.5 102.7 20.9 27.7 139.9 144 26.34 30.4

P/E 16.4 9.9 20.3 16.4 26.5 23.9 16.8 11.7 14.8 13.3 7.6 6.7 13.6 10.7

P/BV 2.1 1.4 1.9 1.7 5.9 5.2 3 2.2 2.8 2.8 1.5 1.2 1.6 1.2

Return on assets 0.99 0.88 1.35 1.5 1.55 1.77 1.68 1.68 1.58 1.57 1.34 1.19 0.89 1.09

Return on equity 18.9 16.3 9.65 11.2 16.74 18.69 19.34 20.29 21.13 23.07 22.6 19.8 14.37 12.86

No. of issued

shares (in mn)671 635 1151 1153 465 2346 410 413 347 352 316 339 120 150

Table 2: Key Protability

Table 3: Key Valuation Metrics of some of the most preferred banks of mutual funds

Table 4: Promotional Strategies of Banks


24/28December 2012

24 NIVESHAK

Co

verStory

Finsight

before the advent of the New Private Sector Banks

headed by HDFC and ICICI bank that changed theway banks did business in India. They introduced

the concept of branding in the banking Industry, atrend followed by Axis, Kotak Mahindra and Yes Bank,while DCB and IndusInd was left behind in the raceof aggressive campaigning. Recent years have seenPSBs like SBI, PNB etc developing their promotionalstrategy as well to stay in the competition.

Increasing accessibility through ATMs and

POS

The private banks extended their reach not onlythrough branches but also through huge number ofATMs. RBI statistics of 2012 reveal that Axis, HDFC

and ICICI, along with SBI comprise of 52% ATMs allover India, among 53 SCBs recognized by RBI. Thedata summarized below suggests only 9 new privatebanks have surpassed all other bank groups innumber of ATMs. Another way through which banksincrease their accessibility these days is through POStransactions by debit card customers.

Innovations in banking

The banking sector in India has undergone aremarkable metamorphosis in the last decade throughinnovative strategies. Needless to mention the new

private banks not only pioneered these changes butalso continue to surprise the consumers with newmoves. Way back in 1998, HDFC Bank joined theCirrus interbank network so that MasterCard holdersworldwide could use its ATMs. In 2001, it became the

first bank in India to launch an International DebitCard, in association with VISA. ICICI, the bank thatunleashed the power of Internet in Indian Banking,launched e-Locker facility to wealth customers andinitiated a 24x7 electronic branch this year. On 6September 2012, it announced the launch of itsservices on social media platform Facebook, an

initiative taken under the tagline Khayal Aapka.

Axis Bank came up with this innovative home-loan product: if you pay all your equated monthlyinstallments (EMIs) in time, it will fully waive thelast 12 payments-a move seen as the banks strategyto break the stranglehold the HDFC and SBI haveon the home loan business. Yes Bank, the youngestand fastest growing bank in India, outsourcedtechnology and used innovation as the key engineto their growth. Not only has it used innovationsfor profitability, but also came up with various

initiatives like Honey Farming and ResponsibleBanking to evolve as a socially responsible, futuristicbrand in the industry. The most striking feature ofthese banks is flexibility, the way they adapt tochanging regulations and consumer demands. WhileHDFCs strategy of increasing the provision cover forits loans helped them to stick to their 30% profitgrowth even in the difficult phases, ICICI showednimbleness in changing their loan mix to focus onretail sector, particularly mortgages and auto loans.

The way forward

The Indian banking industry, strongly regulatedby RBI, has shown great resistance to volatility,particularly in the wake of the global financial crisis,which pushed its global counterparts to the brink ofcollapse. From the above analysis it would be safeto conclude that the new private banks are betterplaced to face the economic turmoil anticipated innear future, although a large section of Indians willcontinue to trust only the PSBs.

The tough competition posed by these late entrantshas been extremely beneficial to the Indian Banking

Sector. Though macro-economic conditions havemade many analysts pessimistic about this sector,the new generation banks continue to deliverunexpected results quarter by quarter and mutualfunds continue to bank on these banks when itcomes to Asset Portfolio.

Fig 5: No of Banks ATMS group wise

Fig 6: Average Spending of debit card cuustomers at POS



25

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NIVESHAK 25

ArticleoftheMonth


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NIVESHAK 25

ArticleoftheMonth


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Sir, I recently came across a sharemarket trader who told me that withongoing fluctuations in interest rates,it might be time to use a bond ladder in

ones portfolio. What does this bond ladder mean?

Well, we all know that bond pricesmove to the rhythm of the interest rates andone often does not have any control overthem. Thus, familiarity with the concept of

bond laddering will help in reducing the risk relatedwith different interest rates while ensuring a regularflow of money for the bond holder.Bond laddering isactually a very simple investment strategy. A bondportfolio that uses the concept of laddering consists

of many bonds with different maturity dates spaced atregular intervals.

So does the face value of bonds havingdifferent maturity dates also have to bedifferent or can it be the same?

The face value of each bond may be thesame or different. Lets take an example, sayyou have invested a sum of Rs. 20 lakhs infive different bonds with a face value of Rs.

4 lakhs each. The first of these bonds has a maturityperiod of one year; the second one has a maturityperiod of two years and so on. This ensures that youhave a consistent flow of cash every year which canbe further invested.

Ok, it sounds quite simple but howdoes laddering actually help in reducing risk?

It is good to see that you want to getinto the depths of this investment strategy.A bond laddering technique helps you handleone of the most common risks bond portfolioowner faces reinvestment. Reinvestment is

often connected to the future movements of interestrates and in this volatile economic environment,fluctuations in interest rates have become a verycommon feature. Thus, it has become imperative forevery investor to guard oneself from such fluctuations.

Lets say you have a bond portfolio that returnsyou an interest of 7.5% till the maturity date. Meanwhileinterest rates keep changing. If you hold all your bondstill the date of maturity then all your bonds will matureon the same date. This means that you can reinvestyour cash on some future rate of interest which maybe lower or higher than the previous interest rate. Iflower, you stand to lose; if higher you stand to gain.This is what we call reinvestment risk. Thus, spreadingout the bond maturity dates over a period of timehelps in spreading out the reinvestment risk.

So is bond laddering a complete win-win situation?

No, not necessarily. Spreading outyour reinvestment risk may actually loweryour returns. Look, a basic principle oflife is when you gain some, you also losesome. Incorporating bond laddering in your

portfolio can actually make you bear extra costs.

What kind of extra costs, Sir?

See, in bond laddering you will have

different bonds with different maturitydates as well as different rates of return.Usually bonds with a longer maturity dategive you a higher return while bonds with a

lower maturity date give you a lower return. Investingall your money in bonds with a longer maturity datemay seem profitable. However, bond laddering in thecurrent situation also has bright prospects. As I said,with bond laddering, every year you will have onebond maturing which means every year you will havemoney to make new investments.

Thank you sir for explaining BondLaddering in such a lucid manner!

CLASSROOM

FinFundaof theMonth

Bond laddering

NIVESHAK 25

Classro

omIIM Shillong

Neha misra


26/28

2626

F I N - Q1. Connect the following:

2 . An investment gala held for the first time in 1979 by Drexel Burnham Lambert

has become increasingly popular today

3. A part of the Bloomsbury Intellectual Group, this radical thinker was involved in one

of the greatest intellectual battles of the 20th century. The Indian Prime Ministerpraised his philosophy at a recent G-20 Summit. Identify the personality.

4. Connect the following pictures:

5. Central Bank of Germany uses this rate to charge other banks for collateralized loan

obligations, it is generally 50 basis points higher than the German Central Banks

Discount rate

6. Company X, a NBFC, has been restructured to form a Non-Operative Holding

Company Y, which later will be converted to a bank once new banking licenses are

issued by RBI

7. This company is promoted by SEWA Bank and also an affiliate of WWB, a global

network created to focus on the need for womens direct access to Financial services

8. What inference do you draw from the picture below?

All entries should be mailed at [email protected] by 10th January, 2013 23:59 hrs

One lucky winner will receive cash prize of Rs. 500/-

1945


27/28

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